DISCOMs face a stark future

The energy sector is undergoing a massive transformation, with large customers opting for direct access from producers, and those in the middle looking for decentralised storage and consumption. Between these forces, the old distribution business faces serious risk, says a report from the Prayas Energy Group.

The economics of the power industry are changing dramatically and rapidly. Driven by a steep fall in prices of renewable power, and with battery storage systems becoming more and more efficient. it now seems that decentralised production and consumption of power will be a big part of the future. What does this mean for the companies that are now in the distribution business? A report from the Prayas Energy Group in Pune earlier this year gives us a lot to think about.

In the last 20 years since the power sector was reformed - primarily by unbundling production, transmission and distribution into separate entities - the distribution companies (DISCOMs) have become the weakest link in the industry. They are battling various challenges such as controlling losses, ensuring financial viability, providing electricity affordably to all households, and reducing inefficiencies in planning. Some states also have significant surplus baseload capacity, resulting in huge burden of fixed charges, and around 40 GW of stranded generation assets. The business model of the DISCOMs is in disarray.

To make things worse, the DISCOMs' average cost of supply is increasing, which makes alternative non-DISCOM supply options such as solar and wind economically attractive for large consumers, at least to significantly reduce their energy drawal from the DISCOM. Those customers have been leaving the DISCOMs, and choosing open access and captive routes to meet their power demands; this is no longer merely an emerging trend, but a significant and real risk already for most DISCOMs, and poses uncertainty about future demand. And the cross-subsidy based business model of the DISCOMs, where larger customers paid more for their power in order to subsidise others, could be doomed.

Already a crisis

Prayas' report points out that this emerging scenario is likely to have two serious implications for the DISCOMs' future. Planning for power purchase, which has always been a weakness in their business models, is likely to become even riskier and more complex. And the loss of cross-subsidising consumers would force DISCOMs to increase the tariff for small, rural, and agricultural consumers, which in turn would increase the need for direct revenue subsidies by state governments. If not managed appropriately, these factors can lead to severe financial stress, not just for the DISCOMs but also for the sector at large.

And the really scary part is that even if their ambitious targets for efficiency improvement are met, that may not be enough to save the DISCOMs. The cost of supply of DISCOMs would still continue to rise. As against this, the cost of other supply options, especially solar and wind, has reduced significantly due to a combination of global developments and competitive procurement strategies adopted in India. Hence, although efficiency improvements are necessary and desirable, they may not be sufficient for mitigating the adverse impacts of the impending changes in the sector.

Thus, the traditional model of managing the distribution sector in India is on the verge of collapse. Crucially, it is not just the fate of DISCOMs that is at stake - as electrification accelerates and millions of newly electrified households join the grid. Also at stake is the fate of all the small, rural, and agricultural consumers. How we manage the DISCOMs' transition to the future will determine their fates too.

A threat, but also an opportunity

The authors of the Prayas report, however, note that within these disruptive forces, there may also be an opportunity to fundamentally reform the distribution sector and bring in desirable changes. Doing that could also make the inevitable transition more orderly and equitable. To do this, we need to transform the role of DISCOMS - into wires licensees and providers of grid services (e.g. balancing), primary suppliers for small and agricultural consumers, and suppliers of last resort for all large consumers. They suggest three strategies, which together can help achieve this.

1. Ensuring long term sales migration: Encourage and gradually mandate large consumers (say above 50 kW load) to move towards long term, permanent open access or captive generation, and thereby make such consumers responsible for both risks and rewards of market-based power procurement. Such long term sales migration would reduce demand uncertainty for DISCOMs and would also aid market development.

2. New Power Purchase Agreements for baseload capacity to be avoided: Without a rigorous, scientific analysis that considers demand uncertainty, all supply options, different instruments such as short term contracts, peaking supply contracts, and purchase from exchanges, DISCOMs should not be allowed to sign any new PPA for long-term baseload capacity. This exercise should also include a truly transparent public process. This would also ensure that the new capacity addition is considered only after existing and under construction capacity at the national level is utilised to the fullest extent.

3. Solar feeders for agricultural supply: With tariff of MW scale solar PV plants at around Rs.3/kWh, deployment of such plants at the substation can provide farmers day-time supply while also reducing subsidy requirements. Such an approach is quickly possible with more and more states separating their agricultural feeders.

The three strategies outlined above together would enable DISCOMs to avoid risks of stranded assets, sub-optimal use of capacity, and increasing costs. This would enable DISCOMs to focus on the 'wires' business and evolve to assume the role of the supplier of last resort (which will be based on market principles for non-DISCOM consumers) and that of a supplier to non-contestable, small, and rural consumers (which will be largely based on existing contracted capacity). This can be seen as a nimble and flexible approach to managing an uncertain future.

A difficult but necessary transition

These changes will not happen without several facilitating policy, regulatory and analytical measures, the report cautions. For example, in order to ensure long term sales migration by large consumers, there should be certainty, for at least 5 years, in charges such as cross-subsidy charge and additional surcharge, removal of procedural hurdles to enable migration and development of electricity market with long-term as well as flexible instruments. Rigorous analysis based on power sector modelling tools would be required to truly assess the nature of additional supply contracts and the capacity addition required by DISCOMs.

Along with this, measures to ensure equitable tariffs, efficiency improvements of the DISCOMs and monitoring of supply quality are essential to ensure affordable, reliable power for small consumers. Governance reform too, figures in this set of necessary changes; for any effective transition, efforts to ensure strong but accountable institutions and transparent and participative processes are imperative.

This is an uphill task, but one that is necessary for the survival of the DISCOMs, the authors point out. As things now stand, the impending transition will unfold chaotically, leaving the DISCOMs stranded with excess capacity and huge losses - and the sufferers of such a fallout will be mostly small and rural consumers with serious implications for state level politics. To avoid such consequences, it is extremely important to intervene now and to guide the inevitable transition in a manner that enables DISCOMs to adapt to the fast-changing realities of the sector.

IndiaTogether18 December 2018

This article has been adapted from the executive summary of the afore-mentioned Prayas report. To download the full report, visit www.prayaspune.org.